Monday, November 11, 2013

Low inflation creating a QE trap

Weak inflation readings in the US continue provide the Fed with the rationale to maintain securities purchases in what amounts to a "QE trap". With the PCE inflation measure once again below one percent, the FOMC doves fear that "taper" could bring about deflationary pressures. The risk of course is that inflation measures remain benign and what was meant to be a short-term policy measure extends beyond anyone's expectations.

Scotiabank: - The Fed’s preferred measure of inflation — the price deflator for total
personal consumer expenditures — came in at +0.9% y/y in
September. We feel that markets are underestimating the importance of
this observation to the Fed. That is tied with April for the softest inflation
reading since October 2009 when the US economy was just beginning to
emerge from recession.

The forward looking inflation measure derived from TIPS yield (breakeven), has now also turned lower after a recent upward movement.

Similarly, we've seen a slump in commodity prices (see discussion), which is another signal of weak inflation readings.

With inflation measures remaining this low, many argue (see story) that there is no rush to begin exiting the current monetary policy. The fact that the US monetary base is now 4.5 times greater than it was 5 years ago and capital markets are now fully addicted to ongoing stimulus does not seem add any urgency for these economists. The longer this goes on, the more difficult will be the exit, making it harder for the Fed to pull the trigger. Welcome to the QE trap.